The Canadian Securities Administrators on Friday issued a notice to investors concerning principal-protected notes (PPNs). The notice spells out some of the features and risks associated with investing in PPNs, and highlights some of the fees that they may charge.

“Your adviser may need to do research to identify the risks, to determine a realistic estimate of your return on investment, and to calculate the total fees,” it notes. “The investment strategy of the PPN manager and the PPN’s fee structure may be very complicated. At present, there are few rules that dictate what PPN managers must tell investors about the investment.”

It also notes that advisors have an obligation to ensure that they recommend only investments that are suitable for their clients. “Providing your adviser with accurate information and asking the questions outlined in this investor watch can help your adviser fulfil his or her duty when considering if PPNs are an appropriate investment for you,” it says.

The CSA notice details the concerns regulators have about the distribution and sale of PPNs and the CSA’s proposed course of action. “The CSA is focusing on the structure and distribution of PPNs because of the recent significant growth in the sale of PPNs to retail investors and the development of increasingly complex structures that pose investment risks that investors may not be fully informed about,” it notes.

“In addition, recent types of PPN products are more complex and pose investment risks that investors may not be fully informed about. The component of each product not covered by the principal protection guarantee has a different degree of risk, which depends on the underlying investment linked to the notes. In some cases, the underlying investment is a hedge fund, fund of funds, or managed futures. Therefore, through the sale of PPNs, intermediaries are selling retail investors products with investment risks that are more like those risks associated with alternative asset classes otherwise not accessible to retail investors without a prospectus,” it adds.

The CSA says that its big concerns are: the adequacy of disclosure, fees, compliance with the know your client (KYC) and suitability obligations, the retailization of alternative investment products, and referral arrangements.

“We propose to consult with industry and other stakeholders about the structuring and marketing of PPNs. These consultations will include discussions about how issuers are using the existing prospectus and registration exemptions for PPNs, how they are interpreting the scope of these exemptions and the types of products they are selling under the existing exemptions,” it says.

Based on the results of these consultations the CSA will determine whether any new regulatory requirements or guidance needed to regulate the offering and sale of PPNs.

In the meantime, it recommends, “Any person planning to sell PPNs should satisfy itself whether its representatives need to be registered and, if so, are properly registered to sell those products. Any registered dealer should also ensure that its representatives have the appropriate training and that they have a thorough enough understanding of the PPN to be able to assess its suitability for a particular client. Any registered dealer and its representatives should assess their policies for ensuring that any PPNs they recommend to clients are suitable.”